Business context and reporting period
Oaktree Capital Group, LLC’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2013. The filing describes a global alternative investment manager with $79.8 billion of AUM. The request metadata names Brookfield Oaktree Holdings, LLC, but the filing identifies Oaktree Capital Group, LLC as registrant; verify the intended issuer.
Oaktree consolidates many funds despite generally holding only minority economic interests. Consolidated revenue, income, assets and cash flows therefore include substantial fund activity and should not be read as wholly attributable to Oaktree or its Class A unitholders. Management’s segment measures exclude fund consolidation and are more useful for assessing the management business, but are non-GAAP measures.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Consolidated revenue | $56.8 million | $31.9 million | $151.7 million | $98.2 million |
| Net income attributable to Oaktree Capital Group, LLC | $42.9 million | $25.2 million | $157.1 million | $68.5 million |
| Basic and diluted net income per Class A unit | $1.12 | $0.84 | $4.64 | $2.49 |
| Adjusted net income (Operating Group; non-GAAP) | $179.6 million | $157.7 million | $812.3 million | $496.9 million |
| Distributable earnings (Operating Group; non-GAAP) | $154.8 million | $120.4 million | $763.0 million | $434.0 million |
| Fee-related earnings (Operating Group; non-GAAP) | $59.8 million | $73.0 million | $184.1 million | $235.5 million |
For Class A holders, adjusted net income was $44.5 million, or $1.16 per unit, and distributable earnings were $34.6 million, or $0.91 per unit, in Q3. For the nine months, those measures were $161.2 million, or $4.76 per unit, and $152.7 million, or $4.51 per unit, respectively. Fee-related earnings attributable to Class A holders were $12.4 million in Q3 and $34.4 million year to date.
Segment revenue for the nine months comprised $552.3 million of management fees, $787.7 million of incentive income and $170.2 million of investment income. Consolidated net income and cash flow include large amounts attributable to fund investors, not Oaktree. A traditional consolidated operating-margin comparison is therefore not a clear measure of the manager’s economics.
At September 30, 2013, Oaktree reported $304.7 million of cash and $706.9 million of U.S. Treasury and government agency securities, against $585.7 million of corporate debt. Its $500 million revolving credit facility was undrawn and available; the company reported covenant compliance. Consolidated funds separately had $2.0 billion outstanding under credit facilities, generally nonrecourse to Oaktree. Consolidated cash-flow statements report $4.7 billion of operating cash flow for the nine months, substantially affected by consolidated-fund investment purchases, sales and maturities; this is not standalone corporate operating cash flow.
Material changes versus comparable periods
- Q3 consolidated revenue rose 78%, while net income attributable to Oaktree rose 70%. Nine-month attributable net income more than doubled, primarily reflecting higher segment incentive income.
- Nine-month segment incentive income increased to $787.7 million from $250.9 million, led by OCM Opportunities Fund VIIb and tax-related incentive distributions. Incentive income is volatile and depends on realizations and recognition conditions.
- Fee-related earnings declined to $184.1 million for nine months from $235.5 million. Segment management fees declined 1.8%, as fee declines from closed-end funds in liquidation outweighed growth in open-end and other strategies; operating costs also increased.
- AUM was $79.8 billion, down from $81.0 billion a year earlier. Management fee-generating AUM increased to $66.9 billion from $66.2 billion, while incentive-creating AUM fell to $32.3 billion from $37.1 billion. Closed-end fund distributions and realizations were significant contributors to these trends.
- Oaktree issued 8.05 million Class A units in May 2013 for $419.9 million of net proceeds, used to acquire interests in its business from existing holders; the company said it retained none of the offering proceeds.
Outlook, risks and unusual items
Management reported continued economic and market recovery, strong asset prices and profitable realizations, but said attractive distressed-investment opportunities were relatively scarce. It identified selected opportunities in European middle-market lending, commercial real estate, shipping and power, and cited investment activity in real estate, mezzanine finance, control investing and newer strategies. The filing gives no quantitative earnings or revenue guidance. Management expected available cash, operations and the revolver to meet working-capital needs for at least 12 months, while noting distributions remain discretionary and could be suspended if cash flow were insufficient.
- Market and valuation risk: $20.2 billion of consolidated-fund investments were Level III. Oaktree cautioned that valuations using significant unobservable inputs may differ materially from eventual realizations. Its sensitivity analysis estimated a 10% decline in fund investment values would reduce fund unrealized appreciation by $3.9 billion, largely attributable to noncontrolling interests; estimated segment investment income would fall $117.5 million and management fees $15.7 million for the period analyzed.
- Interest-rate and financing risk: a 100-basis-point rate increase was estimated to raise annual interest expense on consolidated-fund variable-rate debt by $20.3 million. Oaktree said its swaps made the effect on its own interest expense immaterial under that scenario.
- Commitments and contingent exposures: Oaktree’s undrawn fund commitments were $291.9 million; consolidated funds reported $1.14 billion of potential credit and investment commitments. A fund-backed revolving facility for portfolio companies had $121.2 million borrowed at quarter-end. The filing also describes a corporate-aircraft lease provision that could expose Oaktree to a shortfall of up to $10 million if specified sale conditions are not met.
- Legal and tax matters: the company cited a lawsuit seeking more than $800 million, which it considers without merit and for which it believes loss exposure is remote; proceedings were stayed pending related arbitration. Tax examinations could result in a reduction of approximately $8–$10 million of previously accrued Operating Group taxes within 12 months, according to the company; ultimate outcomes are uncertain.
- Tax receivable agreement: the May offering-related exchanges generated a $134.4 million deferred tax asset and $114.2 million associated payment liability. Amounts due to affiliates included $249.2 million under the agreement. Payments are expected over an extended period; none were paid in the first nine months of 2013.
- Fundraising regulatory risk: new SEC “bad actor” rules could prevent affected funds from using Rule 506 private placements. Oaktree noted that determining the status of affiliated issuers and other third parties may depend on cooperation outside its control.
On November 1, 2013, Oaktree declared a $0.74 distribution per Class A unit, payable November 15 to holders of record November 13. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Confirm the intended issuer, given the mismatch between the request metadata and the registrant named in the filing.
- Review segment non-GAAP reconciliations and distinguish Operating Group results from amounts attributable to Class A holders and consolidated-fund investors.
- Assess the sustainability of incentive income and realizations, the decline in fee-related earnings, and trends in fee-generating AUM and fund distributions.
- Examine Level III valuation assumptions, fund leverage and commitments, and the sensitivity of fee and investment income to market changes.
- Track the lawsuit, tax examinations, tax receivable agreement payments and Rule 506 eligibility exposure, along with the declared distribution and liquidity available to support future distributions.